Facebook: The World’s Biggest Direct-Marketing Company

Having written a big piece about Facebook way back in 2006, I still feel a bit proprietorial about it—although it’s hard to have personal feelings for a Web site that eight hundred million people use every day. But Facebook, although it’s no longer new or cool, is still a fascinating company, especially if you are interested in online media, and the broader economics of the Internet economy. This week, the company announced bumper results for the first quarter of 2014: a billion dollars in pre-tax income and more than six hundred and forty-two million dollars in net income. Earnings were up about twenty per cent from the last three months of 2013. Compared to the same quarter twelve months ago, the firm generated almost three times as much income.

True, in the world of successful tech companies, Facebook is still a bit of a minnow. Apple made $10.2 billion in its latest quarter; Microsoft made $5.7 billion; Google made $3.5 billion. But Facebook has been a public company for less than two years, and during that time it has convincingly answered two questions that were hanging over its I.P.O. in May, 2012, when I described it, somewhat facetiously, as “the ultimate dot-com”: Could it translate its vast user base into dollars? And would it adapt successfully to the mobile world?

The answers to both of these questions turned out to be: yes, and with relative ease. Actually, it was probably pretty arduous for the Facebook staffers who were pulling all-nighters to build out a global advertising platform and mobile apps, but from the outside it looked pretty smooth. Over the past year, revenues have risen by more than two-thirds, and much of this increase has come from mobile. In fact, about sixty per cent of the company’s advertising revenues now comes from smartphones and laptops.

Much of this growth is coming outside the United States. On a global basis, North America is now only Facebook’s fourth-largest market, with a hundred and fifty million active daily users. There are more active daily users in Asia (two hundred and sixteen million); Europe (two hundred and three million); and what the firm calls “Rest of World” (two hundred and thirty-three million). And, while the growth of its user base has inevitably slowed down, over-all engagement with the site is still rising. The proportion of users who log in daily has risen by five per cent since the I.P.O.

Much has been written about Facebook’s cultural and social impact. From a business perspective, it is something new and something old. The new aspects are twofold. Obviously, it is global, ubiquitous, and digital in a way that previous media companies weren’t. (Add to that its two big acquisitions, Instagram and WhatsApp, which are growing rapidly in users but aren’t big businesses yet.) It also benefits enormously from the fact that it doesn’t have to pay for most of its program content: the users generate it themselves. It has to invest in its network and pay for upkeep and development, but once the infrastructure is in place much of the revenue it generates flows straight to the bottom line. That makes Facebook an enviably profitable company. In the most recent quarter, its operating margin was forty-three per cent, which is very high for a media company. Disney, perhaps the most successful old-media company, has an operating margin of about twenty per cent.

But, for all its youth and technological sheen, Facebook is, at heart, a very simple and recognizable business. More than eighty per cent of its revenues come from advertising, which has grown enormously since it started featuring ads in its news stream rather than just in banners. Where Facebook outdoes other big media companies is in its ability to target ads based upon its users’ activities on the site. In many ways, in fact, Facebook is the world’s first global direct-marketing company.

Through its automated advertising platform, advertisers, large and small, can create ads that slip into the news stream of select Facebook users, based upon their age, location, and interests, as reflected in their activities on the site. Every time you click the “like” button, Facebook records it. If you say you like a certain yoga video, chances are you will see ads from local studios cropping up in your news stream. Since the ads are targeted at users’ interests, they can be pretty effective; Facebook provides tools for advertisers to measure just how effective.

About the only other company that can currently rival this targeting model is Google, with its AdWords program of auctioning ads tied to search terms. Sheryl Sandberg, Facebook’s C.O.O., helped to create the AdWords program when she was at Google; now she oversees Facebook’s advertising business. In a conference call after the release of this week’s earnings, she gave a couple of examples of how it is gradually displacing older forms of marketing. One involved Sport Chek, Canada’s largest sports retailer, which “recently decided to pull their paper circulars, which their company have relied on as its primary ad vehicle for ninety-two years, for two weeks and replace them completely with digital spend, a majority of which was on Facebook.” The other is Ben & Jerry’s, which “wanted to drive more sales from its classic flavors. They used a wide range of our targeting capabilities … to reach premium ice cream buyers.” In both cases, Sandberg reported, the companies saw a substantial increase in sales.

The ad spends don’t always pay off. Around the time of the Facebook I.P.O., General Motors famously pulled its ads from the site, saying they weren’t working. Last year, though, GM quietly returned to Facebook, advertising its new Chevrolet Sonic.

None of this means that Facebook is going to destroy the business of other media enterprises, such as broadcast companies, which have been able to increase their ad rates even as their audiences have declined. (In the online world, by contrast, ad rates have been falling steadily.) It also doesn’t mean that Facebook is worth a hundred and fifty billion dollars, which is its current valuation in the stock market. According to traditional valuation metrics, such as the price-to-earnings ratio, and the enterprise value-to-cash ratio, it is very highly valued. But make no mistake about it, Facebook is fast emerging as a global media juggernaut.